June 13, 2013 5:10 pm
Investors lose bet on EM local currency debt
By Pan Kwan Yuk
Investors in emerging market local currency bonds are among the biggest losers from the recent sell-off in emerging market assets. The average EM local currency fund has lost 7.8 per cent since the beginning of May, according to data from Lipper. This compares with a loss of 6.1 per cent on average for EM hard currency funds and 6.7 per cent for EM equity funds. The sharp reversal in performance comes as investors have substantially increased their bets on the locally denominated EM debt this year. As the chase for yield intensified, investors have piled into the asset class – drawn by the higher yields offered by the bonds and the prospect of an added sweetener in the form of foreign exchange gains. Investors have funnelled $20.4bn into EM local debt in the year to date, compared with just $2.5bn for hard currency bonds, according to data from EPFR. The flows into EM local debt this year have already surpassed the $16.7bn the asset class attracted for the whole of 2012. But the twin attractions of local currency debt – higher bond yields and foreign exchange appreciation – have also made it more vulnerable to the recent rise in US Treasury yields. Yields on JPMorgan’s GBI-EM index, which tracks local currency debt, have risen 82 basis points, or 15.34 per cent, since May 22, when the US Federal Reserve hinted that it may start winding down its $85bn-a-month bond buying programme. Meanwhile EM currencies have suffered a sharp correction. The South African rand, Brazilian real, Philippine peso, Indian rupee, and Mexican peso are among the world’s 10 worst performing currencies since May 22 – with losses ranging from 4.3 per cent to 3.2 per cent against the dollar. Sara Zervos, head of the global debt team at Oppenheimer Funds, attributes the sharp sell-off in recent weeks to crossover money from hedge funds pulling out. “Interest rate swaps yields have been going up higher and faster than [EM local currency] bond yields,” she said. “Real money accounts tend to hold bonds. Fast money tends to hold swaps. So my sense is that the sell-off has been initiated by leveraged buyers unwinding their positions rather than real money dumping bonds.” Others think it is only a matter of time before real-money investors pull back. “In retrospect, it is quite clear that positioning in local bond markets has been excessive,” said Benoît Anne, head of EM strategy at Société Générale, in a note to clients last week. “There is now anecdotal evidence that long-term investors have started selling. That may suggest that more pain is on the way. I see little reason to be bullish on EM fixed income against this backdrop.”
